Chidambaram’s ghosts

Narendra Modi has generated much hope and enthusiasm. He has been praised for the Jan Dhan Yojana, the Swachh Bharat Abhiyan, higher FDI limits for defence and insurance, punctuality requirements for bureaucrats and selfcertification of documents by citizens. Some of these are simply extensions of old Congress schemes, but Modi has done a fine sales job.

The stock market has boomed. But the economy has refused to accelerate. Dismal industrial data for two months have prompted many analysts to downgrade their expectations of 5.5% GDP growth in 2014-15. Sajjid Chinoy of JPMorgan, for instance, now predicts just 5.1% growth, a very modest improvement on P Chidambaram’s last two years.

Exports Pulling the Strings

Chinoy notes that the modest uptick in industrial production earlier this year was strongly linked to Indian exports, which grew fast as the world economy picked up. But the world is now slowing, and so are Indian exports. The global slowdown is marked in Europe, Japan and China. The IMF predicts a global GDP slowdown to 3.1%, not much above recessionary levels. This is bad news for exports and industry.

Industrial growth has been a dismal 0.4% for the last two months, destroying hopes of a Modi-inspired surge. In August, manufacturing output actually fell 1.4%. Capital goods production, the essence of new investment, declined 13%. Maybe these are blips that will get ironed out. Yet, today’s combination of high hopes and stagnant production bears an uncanny, depressing resemblance to Chidambaram’s last two years.

Hope Floats, and Sinks

In summer 2012, Chidambaram was recalled to the finance ministry by Sonia Gandhi and given a free hand to launch reforms and accelerate growth after a long period of paralysis and stagnation. He liberalised multibrand retail, promised new bank licences and with Manmohan Singh’s help cleared Rs 6 lakh crore worth of stuck projects. The stock market soared. Investors expected project clearances to translate into fast growth.

Prices looked like getting tamed after years of high inflation, so investors expected interest rates to be cut too. They were willing to give Chidambaram time to deliver, and so glossed over many months of slow industrial and export growth.

Tax revenues did not grow, and so, Plan investment was slashed for fiscal rectitude. Nevertheless, the stock market soared right till May 2013, hoping that good days were round the corner.

Alas, the US Fed then announced it was going to taper its quantitative easing. Billions of dollars flooded out of all emerging markets. India was among the worst-hit, since high inflation had induced massive gold imports and a current account deficit of 4.9% of GDP. When the ‘taper tantrum’ struck and foreigners pulled out billions of dollars, the rupee plummeted from Rs 55 to Rs 68 to the dollar, before stabilising at Rs 65. The stock market crashed. The cleared projects worth crores did not translate into an economic upsurge.

Today, do we sense déjà vu? Will the current combination of soaring political hopes and stagnant production lead to a rerun of the Chidambaram fiasco? Will current optimism be punctured by mass exit by foreign investors? In the last month, billions have exited emerging markets in anticipation of the end of quantitative easing, and the Sensex has suffered. Yet, things could get far worse.

From Worse to Pits?

The biggest FII inflows into India have been into debt markets, not stock markets. Indian interest rates are high, and the rupee has been strong enough to allow foreign investors to hedge their investments profitably through swaps. But what will happen if the mood changes? Suddenly, the huge inflows into the debt markets can become outflows. That will sink the rupee, and panicky foreign investors will try to pull out even more dollars before the exchange rate truly crashes.

Silver lining: India today is much better paced to withstand a pullout. The current account deficit has fallen to below 2% of GDP. Low commodity prices (especially of oil) are offsetting lack of export dynamism.

Low commodity prices are also helping tame inflation and the fiscal deficit. Consumer price inflation is down to 6.7% and wholesale price inflation to 2.4%. Other emerging markets are in far worse shape.

But staving off disaster is not enough. Modi is supposed to bring in ‘achchhe din’ through rapid growth. A hugely disconcerting fact is that all Chidambaram’s and Modi’s efforts haven’t produced a boom in orders for machinery or construction. Lesson: Central clearances are not abinding constraint. The binding constraints are state clearances, activist judges who stay executive orders, NGO-led agitations against land acquisition and mining, and the reluctance of banks to lend more to the broken PPP model in infrastructure.

These problems will not disappear easily. But Modi must immediately tackle them. Optimists will say that five months is not enough to transform India. Fair enough. But Modi must understand that time is running out, and the global scenario is deteriorating fast.